Monday, July 23, 2012

What in the Economy Should Be Stimulated?

Once again another straight forward analysis from AIER.  Basically the relationship between real Personal Consumption Expenditure (real PCE - about 70% of of GDP) and real disposable income is a straight line.  If you want the economy to grow, then you have to increase real disposable income.  That is tough to do with an 8%+ unemployment rate and consumer demand that is weak due to massive de-leveraging.  But, if the government is going to stimulate this is where it has to be done.  If you like this article there is quite a "civil" discussion in the comment section at the website about the value of GDP.

The article and graph are from AIER.

The single greatest driver of the economy is consumer spending. People, not firms, make best use of extra money.

Far and away, the most important factor in determining consumer spending is the buying power in paychecks. Economists call this real personal disposable income. It matters because spending by individuals makes up about 70 percent of all spending. You can’t have a recovery if the consumer stays home.

Through recessions, expansions, and everything in between, the relationship between disposable income and consumer spending is remarkably tight, as the chart above shows. Currently GDP growth is under 2 percent. With the growth of disposable income near zero, it’s not hard to see why the expansion has been anemic.
The relationship between spending and income also has irrefutable policy implications.
Any government policy to speed economic growth should focus on increasing disposable income. That likely means income and payroll tax cuts. Stimulus programs directed toward businesses, and monetary programs directed toward the financial sector such as those established in response to the recent downturn, won’t do the trick. They have resulted in larger cash holdings in corporations and banks, while consumer spending remains low.
Raising taxes might help reduce the deficit, but it would depress consumption. If the Bush-era tax cuts are allowed to expire at year-end, the results could be devastating. Combined with the mandatory spending cuts of the deficit reduction process, every model we have seen projects a decline in GDP of 3-3.5 percentage points. This would easily result in recession in the first half of 2013. Besides the impact of higher taxes on consumer spending, small businesses would have to redirect income to pay taxes rather than to hire. Increases in capital gains and dividends taxes will reduce income and net worth for some, further reducing spending.
Obamacare calls for nearly $300 billion in tax increases in 2013 alone. There are also mandates that imply additional costs to consumers, further reducing the income available for purchases.

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